Rare profit for Bethlehem Area taxpayers: a swap sale in their favor

The Bethlehem Area School Board continued to shed the district's risky debt Tuesday by terminating two more "swaps" -- at rare, positive values for taxpayers.

The market turned in the district's favor Tuesday, letting the district's financial adviser, Public Financial Management of Harrisburg, end the deals, allowing taxpayers to recoup about $2.3 million after fees were paid to banks, financial consultants and lawyers.

"I believe PFM got us to terminate at the right time and the results for the district are good," said board Vice President Judith Dexter.

The district's net payout on the swaps was far higher under PFM than it was under the district's former financial adviser, Les Bear.

Under PFM, taxpayers paid $74,165 in fees to financial consultants, lawyers and banks to end both deals. In 2007, when Bear's old firm Arthurs LeStrange of Pittsburgh ended one swap, which was worth about $1.2 million, fees totaled $643,493, records show. Taxpayers got the rest.

"My understanding is fees are not regulated by law in Pennsylvania," Dexter said. "It is my sincere hope that the Legislature will look at these disparate fees and realize that there needs to be regulation in this area."

Bear has declined to comment on his past work in Bethlehem. The Morning Call reported on the swap-related debt problems in a four-part investigative series in June.

Swaps are a form of derivative financing that were at the center of 2008's worldwide banking crisis. Layered on top of variable-rate bonds, swaps are contractual agreements between a public agency or business and investment banks to bet on variable-rate interest changes.

Like houses, swaps have market values. A swap can have a value for or against taxpayers. If a government agency ends a positive swap, it receives the net earnings after fees are distributed. If it ends a negative swap, the termination payment is doled out on top of fees, which is what happened in May and again last month when the board paid more than $15 million to end two swaps and issue two new fixed-rate bonds and a new variable-rate bond.

Tuesday's terminations followed unanimous votes the board took Monday to end three swaps. The vote called for Scott Shearer of PFM to terminate the deals if the swaps could generate $700,000 for taxpayers after fees are paid. The plan called for the district to keep the bonds' underlying variable-rate debt because the bonds still have other swaps attached to them, and those swaps have negative values.

The board began using swaps in 2003 to finance $278 million in construction projects on the advice of Bear, now-retired Superintendent Joseph Lewis and business manager Stanley J. Majewski Jr. Swaps were supposed to lower borrowing costs by hedging against swings in the bonds' underlying variable rates.

Bethlehem did more swap transactions than any other local government entity in the state. The district's overexposure to market risk helped cause a budget deficit when the economy collapsed in 2008.

The board dumped Bear in June 2008. It hired Shearer's firm last October.

Dexter said the terminated swaps were on the $40 million bond and a $55 million bond, both done in 2007. She said a swap tied to a 2005 $55 million bond could not be terminated.

It is not the first time the board has attempted to change the structure of the $40 million bond's swaps.

The board on July 23, 2007, followed Majewski's recommendation by voting to terminate two swaps to reap $600,000 after fees.

But neither Majewski nor Bear carried out those orders even though the district was guaranteed a positive cash payment up to three days after the vote, records showed. Neither Lewis nor the board knew the swaps had not been terminated.

The state auditor general's office launched a probe of the Bethlehem district's swap deals as a result of the newspaper series. The state report is pending.